Abstract

http://ssrn.com/abstract=1787732
 
 

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Feedback Effects and the Limits to Arbitrage


Alex Edmans


London Business School - Institute of Finance and Accounting; University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Itay Goldstein


University of Pennsylvania - The Wharton School - Finance Department

Wei Jiang


Columbia Business School - Finance and Economics

June 13, 2014

ECGI - Finance Working Paper No. 318/2011
AFA 2013 San Diego Meetings Paper

Abstract:     
We analyze strategic speculators' incentives to trade on information in a model where firm value is endogenous to trading, due to feedback from the financial market to corporate decisions. Trading on private information reveals this information to managers and improves their real decisions, enhancing fundamental value. While this feedback effect increases the profitability of buying on good news, it reduces the profitability of selling on bad news. Hence the feedback effect contributes to an endogenous limit to arbitrage, whereby investors may refrain from trading on negative information, and so bad news is incorporated more slowly into prices than good news. This has potentially important real consequences -- if negative information is not incorporated into prices, inefficient projects are not canceled, leading to overinvestment.

Number of Pages in PDF File: 42

Keywords: Limits to arbitrage, feedback effect, overinvestment

JEL Classification: G14, G34

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Date posted: March 21, 2011 ; Last revised: June 14, 2014

Suggested Citation

Edmans, Alex and Goldstein, Itay and Jiang, Wei, Feedback Effects and the Limits to Arbitrage (June 13, 2014). ECGI - Finance Working Paper No. 318/2011; AFA 2013 San Diego Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1787732 or http://dx.doi.org/10.2139/ssrn.1787732

Contact Information

Alex Edmans (Contact Author)
London Business School - Institute of Finance and Accounting ( email )
Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
University of Pennsylvania - The Wharton School ( email )
3733 Spruce Street
Philadelphia, PA 19104-6374
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
European Corporate Governance Institute (ECGI) ( email )
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
Centre for Economic Policy Research (CEPR) ( email )
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Itay Goldstein
University of Pennsylvania - The Wharton School - Finance Department ( email )
The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

Wei Jiang
Columbia Business School - Finance and Economics ( email )
3022 Broadway
New York, NY 10027
United States
(212) 854-5553 (Phone)

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